#SQFT 4: Searching, Evaluating and Acquiring a site for Development and Profit

Searching, Evaluating and Acquiring sites is a constant filter. We must endless searchng and enough spreadsheets to make us go cross-eyed in order to hopefully make an acquisition – and as soon as that acquisition is made, we must repeat. Ad nauseam. This part of property development is undeniably the most imperative – it is the sales element of any business that ensures it is a business and not a charitable foundation or hobby. We can have a bitching website, transparent business cards, some fucking cool logo created by a dude in Hackney (who’s mode of transport does not allow gear-shifters)  and the title of “Founder” – but without sales, we are at something of a financial deficit.

 

 

A brief insight into my experience

A growing market is a wonderful, safe-feeling environment. I am lucky enough to have experienced about 5 growing markets and happily admit they have delivered a few get-out-of-jail-cards – that I didn’t even notice at the time or after. I just counted the cash.

Property development has something of a glamorous appearing lifestyle  (coming from someone who came into it from about the age of 22 with starry eyes). Who wouldn’t want the opportunity to find a wreck, turn it into a legacy and sell it for multiple times what your peers may be earning in their cubicles jobs? All the while being your own boss. As such, starting this process means sourcing a development site that can become your own little company to enhance in value over time and sell.

Who wouldn’t want the opportunity to find a wreck, turn it into a legacy and sell it for multiple times what your peers may be earning in their cubicles jobs?

My luck I am all too aware of in buying properties that I have developed and made a profit. However, knowing what I know now having learned a lot the hard way – by trial and error – I have greatly refined to what might appear an incredibly pessimistic outlook on any potential site. Namely, my default response to all sites I see is “No”. A site or property now has to wow the hell out of me in terms of scaleability, profitability and  – more than anything else, something that others have not seen in terms of opportunity.

Starting out, our vision is always to look for that wreck of a building that we can transform and sell on. My first development came in the time before “price per square foot” – when valuations were based on gut feel and vendor motivation. Those were wonderful days as with no empirical measurement of a properties value – there were huge opportunities for mis-valuation which would eventually create the accidental profit I know, more than once I managed to acheive in my early years.

My early developments involved a simple side return and a loft conversion – each of which increased the square footage of the flats which sold for more than I bought them for. I would not be able to make that same profit today – mostly because the opportunities of value increase do not exist, but more so – after detailed calculation, I would not have taken the risks I did for the potential profits that could have been made and just as easily lost. As such, I got lucky. In a down-turning market (which exists as I write), I would have lost money. I actually would have sold the properties (if I could) for less than I spent on – this would have been monumental failure in this business.

So over time, I have learned to develop a default “no” to all development opportunities meaning that something has to catch my attention greatly to even take the next step of financially modelling it to gauge its value to me. A property that does not have a side-return infill, a loft conversion, a basement etc, will probably not be the opportunity worthy of a bid. This may sound strange but the quality of the opportunity is not in what we can create, it is what we can profit from – and profit from by a defined percentage as profit can be a safety cushion when we overspend or the market drops. Sometimes coming out evens is the best thing that can ever happen to us. It’s better than losing money.

Of the roughly 150 to 200 properties that I see per year, 3 to 4 might be bought. In a rising or falling market, one thing must remain constant and that is viewings and deal flow – a huge number in to expect a small number out. Once we have identified a site that we believe can yield a profit from our input – we must analyse it in microscopic and forensic detail and Excel must be the application (other types of software do exist, you dinosaur) that we use more than any other. Developing a thorough Excel template for deal analysis is essential but unfortunately (and fortunately) can only get better thorough time and experience. The reverse of a pack of Marlboro Lights is sadly not accepted by many debt providers that I am aware of – though please lease any comments below if you do. Your BOAFP (Back Of A Fag Packet) should be an Excel spreadsheet that covers:

  • Acquisition costs (purchase, taxes, professional fees, legal fees, application fees, due diligence fees, utilities, insurance, accounting etc.),
  • Development costs (build, VAT, contingency, more professional fees, bank fees, warranties, fixtures and fittings etc.),
  • Debt costs (in fees, out fees, expected interest on drawn down money, more contingency on these fees etc.),
  • Sales costs (estate agents fees, legal fees, debt costs).

This should present a Gross Development Cost in order to compare with your Gross Development Value (projected sales). If your GDV does not exceed your GDV by at least 20% – bin it. Or maybe re-work your numbers to see if it could, all the while preventing yourself from optimistic urges.

 

Expected challenges and how to overcome them

The first deal we ever appraise will likely have the following numbers in (and did in my experience):

  • Purchase price;
  • Stamp duty;
  • Legal costs;
  • Build costs (no VAT as we’ll pay the guy in cash – N.B. DANGER!!!);
  • Some sales figure that is dependant on the market rising by around 10% by the time we sell.

The summary figures above can work and deliver a profit (note “lucky” above). It may even happen twice. But a guarantee is that one time, most likely when our confidence may give rise to a dash of ego, we will get bitten hard. That is not possibility, it is a guarantee. Therefore, my default response is no, unless we can shake the hell out of this site, expect financial armageddon yet beleive that a potential profit may exist at the end.

Once we can identify a development site that can deliver profit (see here for advice on identifying that) and have determined what the site is worth to us (not what we are told the price is – that is not relevant to us) – we are away to the races. Ha ha. Not really – a few more hoops ahead.

  • Competitive bidding. Remember the derelict house that hasn’t been touched in 50 years? Expect 20+ bids to come in on that – and don’t bother joining the crowd of rabid dogs – competitive markets do not produce profits in the end but over-paying at the start. Further to that – just don’t bother with auctions. When a group of people are gathered in a room looking for value – the chap at the front’s job is to get them all excited and frothing so much that they temporarily ignore the number that they had on their appraisal, all in favour of winning the cock-fight. Well congratulations, you just spent your profit. You are a cock. It may be rare to find an opportunity that we don’t have to joust for but rare is what we want. If deals grew on trees, we all turn into apples.
  • Moving parts. Agreeing a price can be a straight forward process – but this can be entirely scuppered if other people (factors) are able to impact our potential to profit. Who are these people?
    • Freeholders – if purchasing a flat, it will either be “Leasehold” or “Share of Freehold“. If leasehold, you will need the freeholders permission to carry out much more than a coat of paint – this can be a timely process as there an no restrictions on how long it can take. If buying a share of freehold, you are actually buying a lease but you collectively (with the other member of the building) own the freehold – as such, you need their permission as well. As a general rule of thumb 0f neither of the above will ever happen quickly or easily so make contact as to your intentions as quickly as possible and be fully expectant to cough-up some dollars. Any space outside of the demise of your lease does not belong to you so you will have to buy it from the freehold. Anything that you want to alter in your flat will likely awaken the spare and disposable time of at least one of the others residents. As such, and for no apparent reason, they will object in some way and cause you a headache lasting months in order to state their invalid point. Expect problems and be ready to ease them with money. We purchased a flat once as well as the air rights above it in order to build another floor onto it – this in effect became 2 transactions (one with the seller and one with the freeholder). The price was agreed in around a week but the air rights and License for Alterations from the freeholder took around 9 months of careful negotiation while keeping the vendor of the flat from going bat-shit crazy.
    • Planners – should your development require and alterations to its exterior (extensions etc.), you will need planning permission. It is vitally important to know that planning permission is viable and that your debt does not depend on it being in place. It is far to easy to exchange on a purchase, put in for planning before completion and have it refused. This will mean your debt not being lent at the time of completion and losing your deposit. While there are ways around this, it is better not considered. At the very least – always obtain pre-application advice from the local authority and keep as much contact as possible with the planning case officer throughout the planning process (8 weeks). We once had an application refused (which we had expected so made allowance for in time), so we resubmitted it with the planner’s recommendations of how they would prefer it. 7 weeks later, we put in a call to the planner to check all was ok only to be told the second application was going to be refused. Sh*t-F*ck. Luckily, as we had called him, he advised which element of the scheme was unacceptable allowing us to amend the plans at light-speed and have the application accepted. This was not a welcome activity whilst horizontal, post-lunch in Ibiza. I may have even spilled my rosé.
  • Optimism. When dealing with an extensive spreadsheet, it is very easy to “make a deal work”. Nudging up expected sales value, missing out the odd price, expecting not to pay VAT on a build – all of these things will cause the loss of much if not all projected profit if first appraisals are not honest, verging on pessimistic. This will only happen once after having a bank’s due diligence done on your costs (at your cost) only to show your amateur projections up and lose you your funding. Far better to under-promise and under-deliver as a queue will shortly form at your door carrying bulging briefcases. I have been guilty of making these errors early on but been either helped out early on by lady luck in a rising market or dropped the deal before actually purchasing having performed a stress test on my own evaluation. I’ve learned that a valuable test on an appraisal is to stress the build costs by 20% (up) and the projected GDV by 10% (down). If I am ever too afraid to do this, I drop the deal and celebrate the money I have not lost to my ego.
  • The market. Despite the press’ commentary, the regular dinner party conversation and every economic factor from Trump to Brexit – the truth that all top property professionals know is that no-one can predict the market. We are constantly told that it is at break-neck level and must crash (when things are going well), though rarely that the market is depressed and so it is a great time to buy. If a Ferrari went on sale by 20% – it would not be present in a show room for long, so why do we run when property prices are depressed? Usually, it is collective fear – when things are up we party, down and we run. A such, property investment is best looked at over a 5 to 10 year period. With this level of perspective, we can not only expect but know that market depressions and surges will happen and every time, the “market” of buyers will either run or splurge. Such a simple observation will give a lot of comfort to investors at any stage as they know both scenarios are inevitable. After down comes up and vice versa. As a developer, we must equip ourselves with this knowledge and be prepared to sell in a down market. Should the market rise, we become rewarded for our downside protection.
  • Bidding and offers. By law, any offer made on a property in England has to be reported to the owner – no-one will tell you off. Any guide price for a property is just that, a guide – typically what an owner actually wants (or estate agent says) and no indication of the actual value of the property. If a property comes to market and receives competing bids, the market has said that it is correctly (or under) priced. However, sitting on the market for 6 months indicates that the guide price is incorrect as the market (the buyers that dictate the value by spending it) has not put its best foot forward. This is Christmas time for an investor (which as a developer you are, not a builder). If a property is on the market at £2.5m but attracting no viewings – offer £2m – if it is worst that to you. At worst, your offer will be refused, politely or not. At best, that vendor might need to sell for personal reasons and having bought it 10 years ago for £1.7m, realise they are still making a profit. I cannot remember the number of times if have not made a bid out of laziness only to see some sharper person make a bid well below guide price and proceed to purchase. As a new developer, every property viewed should be appraised on a spreadsheet to calculate it’s actual value to you. Only by carrying this exercise out repetitively do we start to build an internal tool to recognise value. I still models deals (typically 5 per week) and am amazed that my initial feelings on value can be so fart out either way. I always remember the value of financially modelling each and every deal.

 

Top 3 tips to developers starting out

  • View, view view – you cannot see too much property. Good value deals (our focus) are like needles in haystacks. Luckily, very few people are willing to put the time in to search for them so it is not difficult to float to the top if you are willing to work diligently and pound the pavements. When viewing it is highly important to focus on a specific area instead of many. Yes, you are restricting yourself to a specific market but it’s far easier to be an expert in one than an amateur in many.
  • Become an Excel Junkie – build up your spreadsheet template and keep enhancing it as you learn. Every property you see should be modelled for the pure reason of learning what it is worth to you. This will start to become second nature but this skill constantly needs sharpening.
  • Be aware of all of the moving parts in a property deal – at the outset, ensure you know each failure point in a deal. This can include planning permission, freeholders consent, elevating costs and a dropping sales market. If any of the factors can severely compromise your deal – drop it. This game is not for gamblers.

This story is listed in: London Property market, Property development, Property Investment

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£20,308,750

GDV to date

£970,308

Average acquisition

£1,562,212

Average GDV

£351,115

Average Equity raise per deal

£343,558

Average profit per deal

97.75%

Average ROI on equity

11

Deals completed

8

Currently units in progress